Original title: The Battle for Value in Smart Contract Platforms
Author: Grayscale
Compiled by: Yanan, BitpushNews
In the cryptocurrency field of smart contract platforms, there is a value accumulation mechanism called the "flywheel effect". This mechanism is like a snowball, closely linking transaction fees and network usage with the value of tokens, network security and decentralization.
Different smart contract platforms adopt different strategies for fee income. Some platforms increase revenue by setting relatively high transaction fees, while others attract more transactions by lowering transaction fees.
Grayscale’s research shows that fee income can be seen as the main factor driving the value growth of tokens in this space. Of course, there are other important fundamental factors that deserve our attention as they will have an impact on fee income over time.
Ethereum, as a leader in this field, has accumulated huge network fee income after years of successful operation and successfully broke through the $2 billion mark in 2023. At the same time, other smart contract platforms such as Solana are also rising rapidly, and its fee income is expected to reach about $200 million in 2024.
Many people mistakenly believe that crypto assets have no substantial value and are difficult to evaluate using traditional investment methods. But Grayscale's view is exactly the opposite. They point out that smart contract platforms like Ethereum and Solana can actually generate income by charging fees through economic activities on their networks. Grayscale suggests that if investors want to evaluate the value of cryptocurrencies on smart contract platforms, one possible way is to see how much fee income they can generate over time.
Smart Contract Platform Basics Overview
Smart contract platforms such as Ethereum and Solana provide developers with a network environment on which to build decentralized applications. These applications cover a wide range of fields, from games to finance to NFTs. The core function of these smart contract blockchains is that they can process various transactions of the applications they host in a secure and censorship-resistant manner.
Because of this, the value of a smart contract platform is closely tied to the activity of its network. Important metrics for measuring network activity include: the volume of transactions the platform can handle, the scale of users it can support (usually measured in terms of daily active addresses); the value of assets the platform can carry, the so-called total locked value (TVL); and the platform’s ability to monetize block space, which is reflected in network fee income (more on this later).
Each indicator has its own specific meaning. For example, Ethereum’s significant advantage in total value locked (TVL) (up to $66 billion, seven times more than its nearest competitor) fully demonstrates the platform’s liquidity for financial applications advantages and its unique value proposition (shown in Figure 1). In addition, Ethereum’s leading position in the number of ecosystem applications has further spawned strong network effects that attract new developers, new applications, and new users. At the same time, Solana’s daily trading volume, a key indicator, not only highlights its advantages of high throughput and low cost, but also shows that its blockchain technology is very suitable for large-scale application scenarios, such as DEPIN, and projects related to the retail market. , such as NFT and meme coins.
In addition to comparing and contrasting these fundamental metrics across assets, investors can also combine this data with market capitalization, or the market’s current valuation of a particular asset. For example, as shown in Figure 1, although Solana’s total locked value ($4.7 billion) is currently higher than Arbitrum’s ($3.2 billion), Arbitrum’s market cap to TVL ratio (1x) is much lower than Solana’s (16x). These metrics provide investors with a way to gain insight into the relative strengths and weaknesses of different assets, while also helping them identify potential value investment opportunities.
The key role of costs
Although there are numerous ways to evaluate platform network activity in theory and practice, network fee income has undoubtedly become a crucial basic indicator when evaluating the value of smart contract platforms (see Figure 2). This indicator can be understood as the total fee that users need to pay to enjoy network services. Smart contract platforms may have a variety of revenue models, but in the final analysis, they all need to create value for token holders by generating fees.
Similar to the competition between centralized entities in traditional industries, decentralized networks are also competing for fee income in various ways. For example, some smart contract platforms increase fee income by setting relatively high transaction costs, while others try to attract more transaction volume by reducing transaction costs. Both strategies are likely to succeed. Take two hypothetical blockchains as examples:
Example Chain 1: Small number of users and transactions, high cost per transaction
5 users, 10 transactions, $10 per transaction: Network fee revenue = $100
Example Chain 2: Large number of users and transactions, low cost per transaction
100 users, 100 transactions, $1 per transaction: Network fee revenue = $100
This case reveals a phenomenon: even though the number of users and total transaction volume of Chain 2 far exceeds that of Chain 1, the network fee income generated by the two chains is comparable. Of course, indicators such as users and transaction volume are indeed key, but we also need to consider them in conjunction with transaction costs, because this directly determines the level of fee income.
The importance of fee income is clear both empirically and theoretically. For example, Figure 2 shows the relationship between fee income and market capitalization (on a logarithmic scale) for each component of our smart contract platform in the cryptocurrency industry. Although the cryptocurrency market is still in the process of maturing, investors are already able to distinguish between different projects based on fundamental data. Grayscale's analysis shows that the relationship between fee income and market capitalization is quite stable and has a higher correlation with market capitalization than other smart contract platform fundamental measures.
Grayscale emphasizes that there is a close connection between fees and market capitalization, in part because network fee revenue plays a key role in the value accumulation of tokens. Value accumulation means that the protocol constructs tokens in a way that connects network activity to the long-term sustainable value of the token. We can observe different stages of value accumulation through the following three examples: Ethereum, Solana, and Near.
Ethereum: A proven value-accumulating “high-quality chain”
Ethereum is not only the first smart contract blockchain, but also the one with the highest market capitalization. However, since 2022, it has begun to face severe expansion challenges. As the frequency of use increases, network congestion has become increasingly prominent, causing users' transaction fees to rise sharply: on May 1, 2022, the average network fee per transaction was as high as $200.
Nevertheless, the surge in usage and high average transaction fees have also brought huge value accumulation to Ethereum. In 2023 alone, Ethereum's total network fee revenue exceeded $2 billion. Every time a user makes a transaction, the basic fee will be "burned", which means that this part of the coin will disappear from the network permanently, thereby reducing the total supply. At the same time, the tips paid by users will be used to prioritize transactions, and these fees will be rewarded to validators and network security maintainers who participate in staking.
As a result, in 2023, the Ethereum network achieved the "burning" of 2 million Ethereum tokens (1.7% of the supply) through huge revenue, which not only created value for Ethereum holders, but also brought up to US$390 million in rewards to validators and stakers, thereby incentivizing them to work harder to improve the security of the network.
Ethereum has entered a stage of maturity and has fully demonstrated its ability to generate value accumulation. On Ethereum’s mainnet, users are willing to pay high prices to obtain high-quality products—the “product” here is the block space supported by a smart contract platform with top-level network security. This is particularly important for applications that involve large transactions and place a high emphasis on cybersecurity, such as stablecoins or tokenized financial assets. As of June 6, 2024, the platform’s valuation has reached a staggering $458 billion, nearly six times that of any other smart contract platform. This significant advantage undoubtedly highlights its excellent capabilities and market maturity in user monetization.
Solana: Accumulating Value in Exploration "High-Performance Chain"
Unlike Ethereum's fee revenue model, Solana has chosen a unique path and has gradually narrowed the gap with the market leader in the near term. As the second-largest smart contract platform by market capitalization, Solana has been seen as a faster and more economical alternative to Ethereum, with a speed of 335 transactions per second and an average low cost of only $0.04 per transaction. Although Solana processes far more transactions than Ethereum in 2023, its network fee revenue is only $13 million, compared to Ethereum's $2 billion (a difference of 154 times).
In the past, this lack of value accumulation reflected Solana's relative inadequacy; however, in 2024, this is changing. So far, Solana has generated six times more fees than in all of 2023, which has narrowed the fee gap between Ethereum and Solana to 16 times from 154 times in 2023 (see Figure 4). This shift demonstrates that Solana’s model—low transaction costs combined with high throughput—can also create significant economic value.
The significant growth in network fee revenue is mainly due to the significant increase in average transaction fees (up to 37 times compared with last year), rather than relying solely on the overall growth in transaction volume (up only 33% compared with last year) ). Interestingly, while Ethereum’s L2 transaction fees have been reduced due to the Ethereum Cancun upgrade, SOL, traditionally known as the “cheap choice”, has seen an increase in its average fees. While the average transaction fee for Solana users since April 1st ($0.04) is still lower than Ethereum ($4.80), it is higher than L2’s Arbitrum ($0.01).
Compared to Ethereum's L2 solution Arbitrum, Solana's transaction fees have increased for users, which may have some impact on its brand image as a low-cost, high-efficiency chain. However, Grayscale pointed out that from an overall perspective, the increase in fees is still a positive sign. It not only reflects the high activity of users, but also reflects the continued growth of the value of staking participants and token holders.
Near: Leading the way in cryptography, network monetization is emerging
In stark contrast to the two cases mentioned above, Near is a smart contract platform that has seen a lot of recent adoption in non-speculative use cases, but has yet to show significant value accumulation. Near is the underlying platform for KaiKai and Hot Protocol, two of the largest decentralized applications (dApps) in the cryptocurrency space. Among all smart contract platforms, Near has performed particularly well, with 1.4 million daily active users and a throughput that rivals the fastest chains in the industry, such as Solana (see Figure 6).
Despite its significant advantage in user numbers, Near has lagged behind its competitors in monetizing its user base, generating only $4.1 million in fees over the past year. This reflects its relatively immature stage of development, which can also be seen in its market capitalization relative to its competitors ($7.9 billion, compared to $458 billion for Ethereum and $78 billion for Solana). One hundred million U.S. dollars). While the Near network has demonstrated the ability to process transactions at high speeds, it has so far failed to create enough value accumulation for token holders or savers to justify its market capitalization to the level of its larger competitors.
Although Near has yet to achieve significant results in terms of monetization so far, its broad adoption base is certainly a good start. If the Near Network can continue to expand adoption, or increase average transaction fees without reducing network activity (similar to Solana's recent advancements), it has the potential to achieve significant value accrual.
Ethereum, Solana, and Near, three smart contract platforms, represent different stages of maturity for decentralized networks in terms of network fee revenue. Ethereum has had years of stable revenue and growth. Solana has a solid user base and is just beginning to generate significant revenue. Near, while showing traction with its product, in part due to its low cost, has yet to achieve substantial revenue.
Fees and valuations: key points and nuances to watch out for
The fees and valuation issues of smart contract platforms in the cryptocurrency field do contain many points and subtle differences that require careful consideration. The first thing is that each protocol has its own unique way of accumulating value, accompanied by different rates of token issuance (inflation) and consumption (deflation). For those tokens with high inflation rates, the value accumulation effect of fees may be significantly weakened by the large consumption of tokens.
Furthermore, different protocols set their own fee structures. In Ethereum, for example, its transaction fees not only contribute to the destruction of tokens, thereby indirectly benefiting all token holders, but also the priority fees are distributed to validators and stakers. In contrast, Solana's fee distribution mechanism is different: 50% of transaction fees are burned and the remaining 50% belongs to stakers. Recently, a vote decided that Solana's priority fees will be 100% attributed to validators. This strategy reflects Solana's higher requirements for validator hardware to a certain extent.
It is worth noting that the high level of MEV (Miner Extractable Value) activity on Solana brings additional rewards to validators and market makers, but this reward may constitute an "indirect" cost for token holders. Therefore, from a certain perspective, Ethereum's fee structure seems to provide more value back to ordinary token holders, while in Solana's system, validators and market makers may receive more generous rewards.
Similar to how valuations of traditional assets often discount future cash flows back to the present, valuations of crypto assets may involve discounting expected future network fee revenues back to the present. This approach considers the potential growth in adoption, usage, or monetization of a particular network in a different way than the overall fee generation today. For example, it is reasonable to assume that Ethereum’s $458 billion valuation is not based solely on the fees it generates today, but also takes into account its ability to leverage network effects and the potential for future growth in adoption, usage, and fee revenues of second-layer technologies.
Additionally, the valuation of some crypto assets may also include a “monetary premium” component. In other words, users may be willing to hold an asset because it functions as a monetary medium — a medium of exchange or a store of value — and this value often exceeds the network’s ability to generate fee income. For Ethereum in particular, the concept of a “monetary premium” is particularly important when considering its valuation, especially when the token is widely used as a collateral asset across the industry.
in conclusion
If the value accumulation mechanism is properly implemented in the protocol, the growth of network usage will not only incentivize users to hold tokens, prompting them to withdraw from circulation and potentially increase the value of tokens, but will also further encourage users to become validators or holders, thereby improving the security of the network. In addition to contributing to network security, the collection of fees can also incentivize more validators to participate in the project, thereby increasing the decentralization and censorship resistance of the network. Therefore, value accumulation is like a flywheel, closely linking fees, network usage and token valuation, as well as the security and decentralization of the network.
We need to recognize that while fees can be used as an indicator of network maturity, there are many other factors in this flywheel that can affect the growth of the network and its valuation. For example, when an application's adoption rate increases, it attracts more users to join, which in turn attracts more developers to develop in the same ecosystem. Therefore, when evaluating network fees, we should consider them in conjunction with other fundamental indicators and the relative valuation (market cap) of a specific ecosystem.
Looking ahead, it will be critical to continue monitoring the developments of these growth myths. Despite relatively high average transaction costs for users (at $4.8), will Ethereum be able to further increase its fee income on the mainnet through high-value transaction scenarios such as tokenized financial assets? Will Ethereum's fee income grow with the increasing frequency of L2 activity? And how will Solana find a balance between monetization and keeping the cost of on-chain low to prevent users from switching to other low-cost, high-throughput competitors? Will Near attempt to monetize, or will it choose to continue to forgo meaningful revenue opportunities in order to prioritize the expansion of its user base?
These dynamics emphasize the importance of ongoing monitoring of key metrics such as fees, trading volume, active users, and total locked volume (TVL). Grayscale firmly believes that as the crypto asset class matures and its adoption rate continues to grow, the importance of these core indicators will become increasingly significant. They can more deeply reflect the relative advantages and opportunities of smart contract platforms, help investors understand the value of the network in more detail, and thus provide them with more informed decision support.
